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Methodology
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Having purchased 6,200 individual CRE loans with an unpaid principal balance of $6.2 billion over the past three years, Colony Capital continues to dominate the FDIC’s structured sales programme, which offers subsidized financing to institutional investors seeking access to the distressed loans languishing on the balance sheets of failed banks. Since the programme began in May 2008, Colony and other real estate specialists, such as Starwood Property Trust and Rialto Capital Management, have taken down more than 32,000 loans in 18 structured transactions with an unpaid principal balance of $21 billion, according to the FDIC. In its latest transaction, Colony bought a 40% equity stake in 758 sub- and non-performing loans with a book value of $607 million. As with all other asset sales under the FDIC programme, the agency finances 50% of the initial capital outlay for the bidder with a seven-year interest free loan. According to Todd Sammann, principal at Colony, although Colony has acquired some particularly impaired construction and land loans from the FDIC for as little as 20 cents on the dollar, most of its purchases have cost between 50 and 75 cents. Colony’s return target on these investments is a minimum yield of mid-teens. “The patient, zero-coupon leverage in the programme allows us to use a combination of strategies to convert the non-performing loans to performing status through active asset management,” Sammann says. “Once we get there we have a variety of alternatives to monetize those loans. Unlike the balance-sheet lenders, the government is a motivated seller. If they take a loss on the front end, they’re participating in the gains on the back end, addressing the political implications of selling to private capital at market-clearing levels.”
Non-traditional US real estate investors are also finding opportunities in other dysfunctional quarters of the CRE capital markets. Far from waiting for the $340 billion of loans locked in CMBS transactions to come due before they pick off distressed properties, the most aggressive players are seeking fulcrum positions in stressed CMBS transactions. These are typically junior bond or equity positions that have not been completely wiped out and that control lender decisions under inter-creditor agreements. They are also well placed to take advantage of foreclosure sales of the underlying portfolio of properties. “Many of the more sophisticated fund managers are pursuing fulcrum strategies with 2005/06 vintage securitizations financed with excessive leverage. More senior investors are typically pleased to see fresh capital invested and out-of-the-money sub-debt flushed if it helps them avoid realizing losses,” says Sammann.
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